WHAT IS A CFD?
If you are new to trading, you are probably wondering what a CFD is. Even if you are an experienced trader, it doesn’t hurt to refresh your memory on what a CFD is.
A CFD or Contract For Difference is a contract between you as the investor/trader and the broker/seller. The whole purpose of a CFD is to exchange the value of a financial product between the time the contract opens and closes.
CFD trading essentially allows you to capitalize on live trade opportunities in almost any financial market. Financial markets include stocks, forex, commodities, indices, cryptocurrency and many others.
The image below is a perfect visual representation of what CFD trading is:
Now that you have a good foundation on what a CFD is, In order to completely understand how to trade a CFD, there are a few things you will need to know. Let’s begin shall we?
BUYING AND SELLING CFDs
As a trader/investor, you can use a CFD to bet on whether the price of an underlying asset or security will increase or decrease. If you as a trader purchased a CFD, you do not actually own it. You simply receive revenue based on the price change of the asset.
An example of this is instead of physically purchasing a commodity such as Gold or Silver, you can simply bet on whether it will go up or down. You do this by buying (up) or selling (down).
Regardless of the price going up or down, you could potentially make or lose money. If you sell a particular CFD, you are trading on the hope that the particular CFD will have a price reduction. If you buy a CFD, you are betting on the price going up.
Your leverage size will determine how volatile your trading experience will be. What is leverage? Let’s take a look.
CHOOSING YOUR LEVERAGE SIZE
So we now know that you can trade CFDs buy either buying or selling. But how do you actually do it? Well what you now need to know is your leverage size. The size of your CFD will vary depending on the asset class you are trading. CFD’s are a leveraged product. This means that you can place a trade by paying only a fraction of that total value of an asset. So let’s go into the specifics.
Each broker will provider different leverage sizes. If your broker provides 1:100 leverage, this means that every $1 you have is equal to $100, If you have $1,000 it is equal to $100,000, you get the idea.
The leverage size you choose will ultimately depend on your risk tolerance. The higher leverage that you have, the more volatility you will expose yourself to. The highs will be higher and the lows will be lower. Choose a leverage size that you are comfortable with before placing a trade.
CHOOSING YOUR MARGIN SIZE
Depending on who you trade with, each broker will have their own margins needed to open a trade. When it comes to CFD trading, a margin is the amount specifically required to open a position.
For example, let’s say you want to buy 5 Bitcoin contracts. 1 Bitcoin contract would cost $60,000, so 5 would cost $300,000. However, let’s say only 5% margin is required to place this trade, you would only need $15,000.
If you wanted to only buy 1 Bitcoin contract, If Bitcoin is $60,000 and the margin required is 5%, the you would only need $3,000 to place the trade.
It is best to do your research before choosing a specific forex broker to trade with. Find out what leverage they offer as well as the margins required for whatever asset you wish to trade.
THE PROS AND CONS OF CFD TRADING
With many things in this world, there are pros and cons. CFD trading is not excluded from this unfortunately.
Some of the pros of CFD trading include:
- Flexibility – you can place trades on whether you think an asset will rise in price or fall.
- Leverage – Even if you don’t have a lot of many to spare, leverage can come in handy for you. You can use smaller amount of money to open much larger positions. An added benefit to this is that you don’t have to use up all of your capital to start trading.
- Low Fees – CFDs, in comparison to Stocks, usually have much lower fees. Most CFD brokers will not charge you a fee to open and close your positions.
Some of the cons of CFD trading include:
- Financing Fees – If you keep your positions open overnight, unfortunately you will be charged a financing fee. The fee is the cost for borrowing funds through leveraged methods.
- Leverage – We did mention that leverage can be a pro, but it can also be a con. While it does allow for you to earn more, it can also allow for you to lose more if trades don’t go your way. Carefully consider your leverage size before opening any trades. Make sure you are comfortable with the amount of exposure you are giving yourself.
- Overtrading – People who are new to trading can easily keep opening up positions because of the dopamine hit they receive from profits being made. The important thing to keep front of mind is to keep your emotions in check. Overtrading is very common amongst new traders so make sure you ask yourself “If I lost all of my trades, will I still be financially okay?”.
This article was designed to make understanding CFD’s as easy as possible. If you would like to know about what CFD’s are available on the Finlogix platform, feel free to contact me (my email is listed below), have a browse of the platform, practice trading and develop your skills.
If you feel you are ready, post an analysis of a CFD of your choice on our platform for others to read!
Sign up by clicking the link below and begin your trading journey.